Full Faith and Credit: A Golden Assurance

Full faith and credit guarantees offer the insurance of a stable financial organization over a less stable organization's debt. Essentially, if a company is backed by the full faith and credit of another company or agency, it is borrowing the good credit of that agency. When a document, debt or other financial instrument is guaranteed this way, the smaller organization has a higher credit rating and an easier chance obtaining future financing.

Example

One example of a full faith and credit situation is the federal government's backing of the Government National Mortgage Association (Ginnie Mae). Because Ginnie Mae is backed in such a manner, any securities that are derived from Ginnie Mae mortgages are considered to be much higher grade than other mortgage-backed securities. This makes Ginnie Mae's mortgage-backed securities far more desirable on the market.

The federal government also backs up other financial entities. For example, it offers its own full faith and credit to U.S. Treasury securities. When you purchase a bond from the U.S. Treasury, it is backed by the federal government, which provides nearly 100 percent insurance against default. The U.S. government may even offer full faith and credit to an individual state reserve bank or a smaller government entity.

Selecting Full Faith Securities

As an investor, if you want to minimize your risk, you should look for securities of the highest investment grade possible. This means the securities have been evaluated by a ratings institution that determined the issuer is not likely to default or go bankrupt. If you come across a security that is offered by a middle- to low-grade institution, though, you may still consider purchasing the security if it has the full faith and credit of a more stable entity. For example, you may be wary of purchasing shares in a start-up tech company. However, if that tech company is partly owned by and fully backed by the full faith and credit of IBM, you may be less hesitant.

The True Test of Full Faith and Credit

Full faith and credit is not a legally binding agreement. The U.S. government does not cosign on Ginnie Mae mortgages, nor does IBM do so for subsidiaries it may be backing. Full faith and credit is a commitment of the backing organization to attempt to resolve any financial issues that may arise, but it is not a promise to repay the debts of the organization.

Other Applications

Full faith and credit is also used in a clause of the United States Constitution. This application is not financial. Instead, it refers to the duties and responsibilities of each state in the union to recognize the rules, laws and regulations of other states. Essentially, the full faith and credit clause attempts to address the manner by which one state must recognize judgments, papers and contracts of another state. For example, if a couple has married in the state of California, and Nevada offers full faith and credit of the marriage, the couple would still be legally married if they resided in Nevada.

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